Chapter 5 Mishkin

Macreconomics: Policy and Practice (Mishkin)
Chapter 5 Money and Inflation

5.1 What is Money?
1) Money is not ________.
A) income because the former is a stock measure and the latter a flow
B) wealth because the latter is generally used to rocure the former
!) as desirable as barter because the latter is more efficient than the former
") all of the abo#e
$) none of the abo#e
Answer% A
&oic% 5.1 What is Money?
AA!'B% (eflecti#e &hinking
)) Money is not ________.
A) income because the former is a stock measure and the latter a flow
B) wealth because the former is generally used to rocure the latter
!) as inefficient as barter because the latter re*uires a double coincidence of wants
") all of the abo#e
Answer% "
+) Money is another measure of ________.
A) income because they both are flow measures
B) wealth because they both measure the total collection of roerty that ser#es as store of #alue
!) the flow of earnings one draws e#ery two weeks
") all of the abo#e
Answer% $
,) Money ser#es as ________.
A) a unit of account-
B) a store of #alue
!) a medium of e.change
") all of the abo#e
Answer% "
1
!oyright / )01) 1earson $ducation- 2nc.
5) Wealth ________.
A) may ser#e the monetary function of store of value
B) means essentially the same as money
!) differs from money in that wealth is more li*uid
") is the flow that corresonds to the stock of income
Answer% A
3) 'omeone who has 4ust inherited a 5goldmine5 has recei#ed a great deal of ________.
A) wealth
B) money
!) income
") currency
$) li*uidity
Answer% A
6) 7red has always been known as 5the rich kid.5 'trictly seaking- this must mean that
________.
A) 7red has a lot of cash
B) 7red8s income is *uite high
!) 7red won the lottery before he was legally eligible
") 7red has a flashy wardrobe
$) 7red has a lot of wealth
Answer% $
9) &he hrase 5double coincidence of wants5 ________.
A) is useful to e.lain why barter is an efficient ractice
B) refers to two eole who ha#e similar tastes
!) suggests a *uite imrobable circumstance
") clarifies the distinction between income and wealth
Answer% !
:) &he most li*uid asset is ________.
A) stocks
B) bonds
!) cash
") real estate
Answer% !
)
10) 'ub4ect to a few legal and ractical restrictions- anything may be e.changed for anything
else. &he distincti#e ad#antage of money is that ________.
A) it is likely to retain its #alue- whether it is ket or e.changed
B) it has little- if any- use other than e.change
!) it can generate income while it is ket
") it is likely to be acceted by e#eryone in e.change for anything
Answer% "
11) Which of the following is most like money?
A) game arcade tokens
B) board game 5money5
!) credit cards
") baseball trading cards
$) fre*uent flyer miles
Answer% A
1)) A risoner of war cam seems a likely lace for 5cigarette money-5 because ________.
A) nearly all risoners smoke cigarettes
B) of the absence of better alternati#es
!) cigarettes are abundant and easy to count
") the guards can enforce the ractice of acceting cigarettes as a medium of e.change
$) cigarettes retain their #alue o#er time
Answer% B
1+) !haracteristics that enable an item to ser#e well as money include each of the following-
except ________.
A) durable
B) abundant
!) di#isible
") ortable
$) #erifiable
Answer% B
+
1,) 'uose you ha#e a collection of gold coins from the 1:th century. !omment on their
suitability to ro#ide for you each of the three functions of money.
Answer% &he coins are an e.cetional store of #alue. &hey would ser#e well as a medium of
e.change- eagerly acceted by most eole. &hey are a oor unit of account- since their #alue
fluctuates a great deal relati#e to other goods. &he face #alue of the coins is not a reliable
indicator of their worth relati#e to other goods. &his is because they are #alued rimarily as a
store of #alue ;and historical<artistic artifacts)- rather than as a medium of e.change.
5.) &he 7ederal (eser#e 'ystem and the !ontrol of the Money 'uly
1) 2n modern economies- the suly of money deends mainly on the economy8s ________.
A) ta. rates
B) mining of recious metals
!) net e.orts
") growth of outut of goods and ser#ices
Answer% $
&oic% 5.) &he 7ederal (eser#e 'ystem and the !ontrol of the Money 'uly
)) 2n addition to the chairman of the Board of =o#ernors- the 7>M! consists of ________.
A) 'i. rotating members of the Board of =o#ernors and fi#e residents of 7ederal (eser#e banks
B) 'i. other members of the Board of =o#ernors- four rotating bank residents and the resident
of the ?ew @ork 7ederal (eser#e
!) 'i. other members of the Board of =o#ernors and fi#e residents of 7ederal (eser#e banksA
all twel#e rotating members
") &wel#e 7ederal (eser#e Bank residents
Answer% B
+) &he 7ederal (eser#e 'ystem consists of ________.
A) ele#en district banks and a board of go#ernors
B) ten district banks and the 7>M!
!) ele#en district banks
") twel#e district banks and a board of go#ernors
Answer% "
,
,) &he 7>M! ________.
A) meets four times a year to decide on how to conduct oen market oerations that influence
the money suly
B) meets si. times a year to decide on how to conduct oen market oerations that influence the
money suly and interest rates
!) meets eight times a year to decide on how to conduct oen market oerations that influence
the money suly and interest rates
") meets twel#e times a year to decide on how to conduct oen market oerations that influence
interest rates
Answer% !
5) >en Market oerations consist mainly of ________.
A) the go#ernment buying and selling ri#ate securities in the oen market
B) the 7ed buying and selling go#ernment securities in the oen market
!) the go#ernment selling its own securities in the oen market
") the 7ed setting rates for securities traded in the oen market
Answer% B
3) When the 7ed sells go#ernment securities in the oen market- the money suly ________
because ________.
A) decreasesA banks lose li*uidity- they make fewer loans and checking account deosits
decrease
B) increasesA banks gain li*uidity- they make more loans and checking account deosits increase
!) increasesA banks lose li*uidity- they make more loans and checking account deosits increase
") decreasesA banks gain li*uidity- they make fewer loans and checking account deosits
decrease
Answer% A
6) When the 7ed buys go#ernment securities in the oen market- the money suly ________
because ________.
A) decreasesA banks lose li*uidity- they make fewer loans and checking account deosits
decrease
B) increasesA banks gain li*uidity- they make more loans and checking account deosits increase
!) increasesA banks lose li*uidity- they make more loans and checking account deosits increase
") decreasesA banks gain li*uidity- they make fewer loans and checking account deosits
decrease
Answer% B
5
9) >en market oerations alter the money suly by ________.
A) influencing banks8 ability to make loans to indi#iduals and cororations
B) adding currency to or withdrawing currency from banks8 #aults
!) adding currency to or withdrawing currency from the checking accounts of indi#iduals and
cororations
") influencing banks8 ability to make loans to the go#ernment
Answer% A
:) Which of the following is true for the $uroean !entral Bank ;$!B)?
A) its e.ecuti#e board meets more often than the 7>M!
B) each member country8s central bank has similar functions to the 7ederal (eser#e Banks
!) it is housed in 7rankfurt- =ermany
") all of the abo#e
Answer% "
10) Which of the following is true for the $uroean !entral Bank ;$!B)?
A) its e.ecuti#e board meets less often than the 7>M!
B) the members of its e.ecuti#e board ha#e lifetime aointments
!) it is a more decentraliBed system than the 7ederal (eser#e
") all of the abo#e
Answer% !
11) !urrent 7ederal (eser#e olicy focuses on interest rates- rather than on monetary aggregates-
because ________.
A) monetary aggregates do not ro#ide clear or consistent signals to guide olicymakers
B) oen market oerations affect interest rates more directly than they affect monetary
aggregates
!) according to the 7isher effect- the interest rate is a key determinant of the inflation rate
") all of the abo#e
Answer% A
3
1)) Both the 7ederal (eser#e 'ystem in the Cnited 'tates and the $uroean !entral Bank are
comrised of geograhically disersed Banks. Dow might such decentraliBation contribute to
successful monetary olicy?
Answer% &he economies of both the C.'. and $uroe encomass many regions with distinct
economic secialiBations- income le#els- demograhics- etc. 1olicymakers need to be aware of
this heterogeneity and of how the olicies under consideration might imact some regions
differently than others. Da#ing had a role in the design and selection of olicies- officials and
citiBens at the regional le#el will be more willing and able to suort and to imlement the
olicies.
5.+ Measuring Money
1) &he 7ed8s narrowest measure of money is ________.
A) M1
B) M)
!) M+
") all of the abo#e
Answer% A
&oic% 5.+ Measuring Money
)) M1 differs from M) because ________.
A) M) includes comonents that are less li*uid than any comonent of M1
B) M1 does not include sa#ings deosits and M) does
!) M1 is included in M) but M) has more comonents
") all of the abo#e
Answer% "
+) M1 differs from M) because ________.
A) M1 includes demand deosits and M) does not
B) M1 includes currency held by the nonbank ublic and M) includes only currency held by
banks
!) M1 includes non interestEbearing checking accounts and M) includes interest bearing time
deosit accounts
") all of the abo#e
Answer% !
6
,) M1 differs from M) because ________.
A) M1 is less li*uid than M)
B) M1 includes demand deosits and M) does not
!) M1 includes only the most li*uid forms of money and M) includes all of M1 and some less
li*uid items
") all of the abo#e
Answer% !
5) M1 does not include cash that is held in A&Ms or bank #aults- because ________.
A) no one really owns that money
B) that money is included in M)
!) that money earns no interest
") the right to access that money is counted already as bank deosits
Answer% "
3) 7inancial inno#ations such as direct deosit of aychecks- electronic ayment of bills- and
automated teller machines ;A&Ms) ha#e likely ________.
A) had minimal effect on M1 and M)
B) reduced the siBe of M) relati#e to M1
!) increased both M1 and M) relati#e to ="1
") caused the growth rates of M1 and M) to become more stable
$) reduced the siBe of M1 relati#e to M)
Answer% $
6) &yically- when someone borrows money from a bank- M) ________- because ________.
A) increasesA the money is held for a while in a li*uid form
B) decreasesA the money is held for a while in a li*uid form
!) does not changeA the loan affects only the subcategories within M)
") decreasesA of the decline in the bank8s #ault cash
Answer% A
9) Which of these transactions results in an increase in M1?
A) withdrawal of F100 cash from your checking account
B) certificate of deosit matures- adding F5)0 to your checking account
!) deositing a bank loan of F,00 into your sa#ings account
") deositing a F+00 aycheck into your sa#ings account
Answer% B
9
:) Which of these transactions results in an increase in M)?
A) certificate of deosit matures- adding F5)0 to your checking account
B) withdrawal of F100 cash from your checking account
!) deositing a bank loan of F,00 into your sa#ings account
") deositing a F+00 aycheck into your sa#ings account
Answer% !
10) 2f the euro relaces the C.'. dollar as the world8s most oular currency- that will likely
________.
A) reduce M1- without affecting M)
B) reduce M)- without affecting M1
!) cause a temorary increase in M1
") affect neither M1 nor M)
Answer% $
11) As of )010 the outstanding C.'. currency is F96) billion- which imlies that the tyical C.'.
citiBen holds F)-900 in cash. 2s this an accurate inference? Why?
A) @esA because di#iding total currency of F96) billion by total C.'. oulation in )010 roughly
works out to F)-900 er erson
B) ?oA because criminals and foreigners hold large sums of dollars- so the a#erage citiBen holds
far less.
!) ?oA because the a#erage citiBen robably does not ha#e F)900 in her checking account to
back u all that cash
") @esA because the 7ed rarely makes accounting mistakes when comuting M1
Answer% B
1)) &he rincial reason;s) that so much C.'. currency is held outside the C.' is ;are) ________.
A) many eole around the world trust the C.'. dollar more than any other currency
B) banks all around the world find it con#enient to hold large amounts of C.'. dollars
!) C.'. citiBens and cororations send a lot of dollars abroad
") all of the abo#e
Answer% A
:
1+) (ecent financial turmoil has caused many eole to increase sa#ing and to refer assets that
are ercei#ed to be relati#ely safe and li*uid. What are the likely effects on M1 and M)?
Answer% 2ncreased sa#ing imlies reduced consumtion- so holding of the most li*uid assets-
M1- should decline. 2nstead- eole will hold more of the less li*uid- interestEbearing assets
within M). 2f eole are shifting away from illi*uid assets like cororate stock in fa#or of assets
like money market mutual fund shares- then M) should rise.
1,) !redit cards are a oular means of ayment. Why are credit card accounts not included in
M1 or M)? Are credit cards of no rele#ance to these money measures?
Answer% A urchase using a credit card is the same as taking out a loan. 2n the transaction- no
medium of e.change asses between the buyer and the seller. At a later time- the seller recei#es a
ayment- and the buyer must gi#e a corresonding amount to the credit card issuer. &he use of
credit cards does tend to reduce M1 relati#e to M)- since many transactions can be co#ered by a
single monthly ayment on ones credit card account- reducing the desired *uantities of cash and
checking account balances.
5., Guantity &heory of Money
1) &he *uantity theory of money ________.
A) is the roduct of classical economists
B) links total income to a country8s suly of money
!) is deri#ed from the e*uation of e.change
") all of the abo#e
Answer% "
&oic% 5., Guantity &heory of Money
)) &he *uantity theory of money ________.
A) is the roduct of Heynesian economists
B) links total income to a country8s suly of money
!) e.lains why the e*uation of e.change is true by definition
") all of the abo#e
Answer% B
10
+) &he *uantity theory of money ________.
A) was best e.lained by 7isher8s book"The Purchasing Power of Money"
B) links total money suly to a country8s demand for money
!) e.lains why the e*uation of e.change is true by definition
") all of the abo#e
Answer% A
,) &he *uantity theory of money e.lains how ________ deends on ________.
A) real ="1A the money suly
B) the rice le#elA the demand for money
!) the money sulyA the #elocity of money
") all of the abo#e
Answer% $
5) &he #elocity of money ________.
A) reresents the a#erage number of times a dollar turns o#er through the year
B) ro#ides the link between the money suly and nominal income
!) times the money suly should e*ual total income according to the e*uation of e.change
") all of the abo#e
Answer% "
3) &he #elocity of money ________.
A) reresents the a#erage number of times a dollar is sent in a gi#en year
B) ro#ides the link between the money suly and money demand
!) times the money suly should e*ual real ="1
") all of the abo#e
Answer% A
6) &he e*uation of e.change ________.
A) states that the *uantity of money multilied by #elocity must e*ual nominal income in a gi#en
year
B) describes a relationshi that is true by definition
!) shows that real ="1 must e*ual real money balances times the number of times a dollar turns
o#er in a year
") all of the abo#e
Answer% "
11
9) &he e*uation of e.change ________.
A) states that the *uantity of money di#ided by #elocity must e*ual nominal income in a gi#en
year
B) is only an identity if we do not understand the determinants of #elocity
!) shows that nominal income must e*ual real money balances times the number of times a
dollar turns o#er in a year
") all of the abo#e
Answer% B
:) According to 2r#ing 7isher- #elocity ________.
A) is determined by institutions that affect the way indi#iduals transact
B) is affected by institutions only gradually
!) is assumed constant in the short run
") all of the abo#e
Answer% "
10) According to 2r#ing 7isher- #elocity ________.
A) is determined by the way banks alone conduct transactions
B) e*uals the number of transactions times the a#erage rice er transaction all di#ided by total
money balances
!) can change #ery *uickly on short notice
") all of the abo#e
Answer% B
11) &he *uantity theory of money ________.
A) is formulated in terms of aggregate outut because the nominal #alue of transactions is
difficult to measure
B) assumes that the nominal #alue of transactions are a constant ortion of aggregate outut
!) assumes #elocity is constant in the short run
") all of the abo#e
Answer% "
1)
1)) &he *uantity theory of money ________.
A) is formulated in terms of aggregate outut because the nominal #alue of transactions is
difficult to measure
B) tells us how much money is held for a gi#en amount of nominal sending
!) imlicitly tells us the *uantity of money that eole want to hold
") all of the abo#e
Answer% "
1+) &he *uantity theory of money tells us that real money balances are roortional to income-
since ________.
A) #elocity is assumed constant in the short run
B) the suly and demand of money are e*ual in e*uilibrium
!) changes in the *uantity of money lead to roortional changes in the rice le#el
") all of the abo#e
Answer% "
1,) 7rom the e*uation of e.change- if both nominal income and the *uantity of money ;M)
trile- the rice le#el ;1) increases by 50 ercent and #elocity ;I) remains constant- then real
outut ;@)________.
A) also triles
B) increases by 50 ercent
!) doubles
") decreases by 50 ercent
Answer% !
15) 7rom the e*uation of e.change- if both nominal income and the *uantity of money ;M)
double- the rice le#el ;1) decreases by 50 ercent and #elocity ;I) remains constant- then real
outut ;@)________.
A) also doubles
B) triles
!) *uadrules
") decreases by 50 ercent
Answer% !
1+
13) 7rom the e*uation of e.change- if both real income ;@) and the *uantity of money ;M)
double and the rice le#el ;1) remains constant- then #elocity ;I)________ and nominal income
________.
A) remains constantA doubles
B) doublesA remains constant
!) doublesA doubles
") decreases by 50 ercentA *uadrules
Answer% A
16) 2n the *uantity theory of money- which of these #ariables is endogenous?
A) the rice le#el
B) the #elocity of money
!) real outut
") the money suly
Answer% A
19) 2n the *uantity theory of money- the assumtion that aggregate outut is fi.ed is based on the
#iew that ________.
A) wages and rices are erfectly fle.ible in the long run
B) the #elocity of money is constant in the short run
!) the demand for real money balances is roortional to income
") changes in the *uantity of money lead to roortional changes in the rice le#el
Answer% A
1:) &he *uantity theory of money ________.
A) is used by classical economist to e.lain how changes in the *uantity of money lead to
roortional changes in the rice le#el.
B) gi#es mathematical grounding for the #iew that a country8s central bank determines the
general rice le#el through control of the money suly.
!) imlies that changes in the money suly ha#e no long run imact on real #ariables
") all of the abo#e
Answer% "
1,
)0) &he *uantity theory of money ________.
A) is used by classical economists to e.lain how fre*uent changes in #elocity lead to infre*uent
changes in the rice le#el.
B) gi#es mathematical grounding for the #iew that a country8s central bank determines the
general rice le#el through control of the money suly.
!) imlies that changes in the money suly ne#er ha#e an imact on real #ariables
") all of the abo#e
Answer% B
)1) &he roosition that changes in the money suly ha#e no longErun effect on real #ariables is
known as the ________.
A) classical dichotomy
B) *uantity theory of money
!) neutrality of money
") 7isher effect
Answer% !
))) &he roosition that the amount of goods and ser#ices roduced in an economy in the long
run is not affected by the rice le#el is known as the ________.
A) neutrality of money
B) classical dichotomy
!) *uantity theory of money
") 7isher effect
Answer% B
)+) &he roosition that the #elocity of money is fairly constant in the long run is known as the
________.
A) neutrality of money
B) classical dichotomy
!) *uantity theory of money
") 7isher effect
Answer% $
15
),) &he *uantity theory of money ________.
A) imlies that inflation e*uals the ratio of the growth rates of the money suly and of real
income
B) ro#ides central banks with a tool to re#ent the rate of inflation from fluctuating
!) imlies that- in the long run- changes in the money suly will be matched by changes in real
income
") all of the abo#e
Answer% $
A) focuses mainly on the close link between short run fluctuations in #elocity and the rice le#el
B) works #ery well for the C.'. but it does not hold emirically for other countries in the long
run
!) ro#ides a long run theory of inflation because it is based on the assumtion that rices and
wages are fully fle.ible
") all of the abo#e
Answer% !
A) suggests that inflation is always and e#erywhere a monetary henomenon which has been
shown to always be suorted by the data
B) #alidates the classical assumtion that wages and rices are comletely fle.ible in the short
run
!) ro#ides a better descrition of short run fluctuations in inflation and money growth than the
link between these #ariables in the long run
") all of the abo#e
Answer% $
)6) Dow ha#e financial inno#ations such as direct deosit of aychecks- electronic ayment of
bills- and automated teller machines ;A&Ms) affected the #elocity of money and the demand for
real money balances?
Answer% Because of these inno#ations- each unit of money is more *uickly and easily a#ailable
for transactions. $ach unit of money is transacted more fre*uently- so #elocity is increased. A
gi#en #olume of transactions can be accomlished with fewer units of money- so the demand for
real balances is reduced.
13
)9) 'uose @ J 100- 1 J 90- and I J +.). 2f @ rises to 105- and the inflation rate is 10 ercent-
what is the new #alue of M?
Answer% 105 K 99 J :-),0 J M K +.). M J )-996.5. $*ui#alently- 100 K 90 J M K +.)- so M J
)-500. 'ince 1 K @ rises from 9-000 to :-),0- an increase of 15.5L- M must rise by 15.5L J
)-500 K 1.155 J )-996.5
AA!'B% Analytical 'kills
5.5 Dyerinflation- 2nflation and 2nterest (ates
1) Dyerinflation tyically ________.
A) describes eriods of e.treme rice increases of o#er 50L er month or 1-000L er year
B) is a a result of e.treme eriods of money growth that tend to come only from large fiscal
imbalances
!) affects both oor and de#eloed economies
") all of the abo#e
Answer% "
&oic% 5.5 2nflation
)) &he main reason that hyerinflation renders a currency worthless is that ________.
A) the go#ernment cannot rint money fast enough to kee u with the rising rices
B) laws against raising rices are easily e#aded
!) reducing go#ernment e.enditures is olitically unoular
") the go#ernment8s 5official5 inflation rate is always a gross understatement
$) as soon as inflation seems out of control- e#eryone knows that the currency will soon lose
whate#er #alue it has today
Answer% $
&oic% 5.5 2nflation
+) &he real interest rate ________ inflation ________.
A) is unaffected in the long run byA because of the classical dichotomy
B) mo#es one for one with e.ectedA in the long run
!) always increases withA but because of the 7isher effect lower e.ected inflation ensues
") all of the abo#e
Answer% A
&oic% 5.5 2nflation
16
,) &he real interest rate ________ inflation ________.
A) subtracted from the nominal rate yields e.ectedA according to the 7isher e*uation
B) mo#es one for one- in the long run- with e.ectedA according to the classical dichotomy
!) always increases withA but because of the 7isher effect lower e.ected inflation ensues
") all of the abo#e
Answer% A
&oic% 5.5 2nflation
5) &he 7isher effect ________.
A) comes from combining the 7isher e*uation and the classical dichotomy
B) redicts that in the long run nominal rates will rise with increases in e.ected inflation
!) shows that in high inflation we tyically see high nominal rates
") all of the abo#e
Answer% "
&oic% 5.5 2nflation
3) 2nflation ________.
A) is costly because the classical dichotomy may not always hold
B) that is anticiated ;or e.ected) can be costly
!) is costly for many reasons but chief among them is that inflation makes it more difficult to
lan for the future
") all of the abo#e
Answer% "
&oic% 5.5 2nflation
6) With increases in inflation demand for money that does not earn a return decreases. !arrying
less cash in our ockets means higher ________.
A) shoeEleather costs
B) menu costs
!) caital gain ta. bills
") all of the abo#e
Answer% A
&oic% 5.5 2nflation
19
9) With high inflation ________.
A) stock market in#estors are always worse off than consumers and households
B) roducers are always worse off than consumers
!) creditors are always worse off than debtors
") all of the abo#e
Answer% !
&oic% 5.5 2nflation
:) 2nflation might lead to ________ because ________.
A) lower demand for stocksA of ta. distortions
B) lower demand for cashA money does not tyically yield interest
!) uncertain or une#en demand for goodsA higher fluctuations in relati#e rices make it harder
for consumers to comare among goods and make rational consumtion decisions
") all of the abo#e
Answer% "
&oic% 5.5 2nflation
10) 2nflation might lead to ________ because ________.
A) higher demand for stocksA as the rice le#el increases so do stock rices
B) higher roduction costsA businesses ha#e to ad#ertise more often due to faster rice re#isions
!) lower transaction costsA we would hold less cash
") all of the abo#e
Answer% B
&oic% 5.5 2nflation
11) 2nflation ________.
A) is more costly when it is anticiated than when it comes as a surrise
B) makes it more difficult to lan for the future- whether it is a surrise or not.
!) induces distortions in the money and goods market but not the labor market
") all of the abo#e
Answer% B
&oic% 5.5 2nflation
1:
1)) 2nflation leads to ________.
A) increased #ariability of relati#e rices only when it is anticiated
B) increased #ariability of relati#e rices only when it is unanticiated
!) increased #ariability of relati#e rices whether inflation is anticiated or not
") lower #ariability of the general rice le#el only when it is #ery high
Answer% !
&oic% 5.5 2nflation
1+) 2nflation may imose little- if any- cost on the economy- if ________.
A) laws against e.cessi#e rice increases are enforced effecti#ely
B) the go#ernment subsidiBes menu costs
!) rice increases are fully anticiated
") the 7isher effect holds true
$) the rate of rice increase is so slow that eole do not feel comelled to alter their beha#ior
Answer% $
&oic% 5.5 2nflation
1,) "uring the =reat 2nflation of the 1:60s- ;a) the growth rates of M1 and M) were higher than
re#iously- and ;b) the growth rate of M) was much higher than the growth rate of M1. $.lain
how the high inflation of the decade relates to each of these facts .
Answer% By the *uantity theory of money- raid growth of the money suly ;relati#e to the
growth rate of aggregate outut) causes the inflation rate to be high. When inflation is high-
holding cash and nonEinterest bearing deosits is costly- so eole shift as much money as
ossible into interestEbearing accounts- so the narrow monetary aggregate M1 does not grow as
fast as the broader aggregate M). By the 7isher effect- nominal interest rates rise with e.ected
inflation- so interestEbearing accounts ro#ide some comensation for inflation.
&oic% 5.5 2nflation
15) 2nflation interferes with the functions of money. Which of the three functions is imaired-
e#en when the inflation rate is *uite low? !onsidering higher rates of inflation- which function is
affected ne.t? Which function of money is the last to suffer substantial damage from inflation?
Answer% A conse*uence of e#en low inflation is to undermine money8s function as a store of
#alue. At somewhat higher rates- inflation comlicates the use of money as a unit of account-
because of increased #ariability of relati#e rices. As the inflation rate goes higher- money loses
its ability to ser#e as a medium of e.change.
&oic% 5.5 2nflation
)0
13) Dow might inflation- e#en if fully anticiated- re#ent the classical dichotomy from holding-
e#en in the long run?
Answer% &he classical dichotomy asserts that outut is determined solely by the aggregate
roduction function and the *uantities of factors a#ailable. 2nflation is like a negati#e technology
shock that lowers roducti#ity. 'hoeEleather and menu costs reresent uses of resources that add
nothing to aggregate outut. Because rice increases throughout the economy are sread out o#er
time- it is rational to react to the temorary changes in relati#e rices- e#en if the changes are
known to be temorary. &his causes distortions in the allocation of resources- and temorary-
rational distortions are distortions- nonetheless.
&oic% 5.5 2nflation
16) Cnanticiated inflation always benefits somebody- so the o#erall cost cannot be higher than
it is for anticiated inflation. !omment.
Answer% 2t is true that mistaken e.ectations of inflation cause one arty to a transaction to get a
better deal than intended- at the e.ense of the other arty. But the true #alue of that better deal is
reduced by the fact that neither arty knows- in ad#ance- who will win. 7ew workers- for
e.amle- would refer to be aid on the basis of a lottery in which losing is as likely as winning.
Moreo#er- unanticiated inflation is difficult to recogniBe- e#en after the fact. 2f the siBe of your
nominal wage increase e.ceeds your e.ectation of inflation- does that mean your real wage is
higher- or that your e.ectation was mistaken? By the time you figure it out- you may ha#e made
a wrong decision.
&oic% 5.5 2nflation
5.3 2nflation and 2nterest (ates
1) &here are no *uestions for this section.
Answer%
5.6 &he !ost of 2nflation
1) &here are no *uestions for this section.
Answer%
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Chapter 5 Money and Inflation

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